CAIIB - RISK MANAGEMENT

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CAIIB- RISK MANAGEMENT MODULE B

• G.R.Rao, Faculty, IIBF

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WHAT IS RISK

• EVERY ACTION HAS A REACTION
• IF REACTION IS FOR OUR BEENFIT NO WORRY AND NO
  RISK
• IF IT IS AGAINST OUR INTEREST ONLY WE ARE WORRIED
  AND THAT IS RISK
• RISK IS THEREFORE POSSIBILITY OF A NEGATIVE
  RESULT FOR OUR ACTIONS
• COULD BE DUE TO US OR BEYOND US

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RISK Contd

• RISK IS SUPPOSED TO HAVE BEEN DERIVATIVE OF
  RISICARE WHICH MEANS TO DARE
• DARING IS TO TAKE STEPS RECOGNISING THE POTENTIAL
  FOR LOSS
• EXTENT OF THIS BEHAVIOUR IS TAKER SPECIFIC
• MORE RISK IS TAKEN IN VIEW OF POTENTIAL FOR
  HIGHER YIELD

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RISK Contd

• DUE TO RISK EITHER , PROFITS AND CAPITAL MAY GROW
  MULTIFOLD OR BUSINESS MAY BE WIPED OUT
• NEVERTHLESS WE CANNOT BE RISK FREE/AVERSE BANKER
  LIKE A SHIP IN A PORT
• BANKING IS THEREFORE RISK MANAGEMENT

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RISK Contd

• RETURN IS THEREFORE RELATED TO RISK
• RETURNS FROM BUSINESSES ARE TO BE ADJUSTED FOR
  RISKS FOR COMPARABILITY-THIS IS RAROC

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BANKING BUSINESS

• BUSINESS IS BROADLY DIVIDED INTO ON BALANCE SHEET
  AND OFF BALANCE SHEET ACTIVITIES.
• ON BALANCE SHEET ACTIVITIES ARE BANKING BOOK
  (DEPOSITS ADVANCES) AND TRADING
  BOOK(INVESTMENTS)
• BANKING BOOK HAS NO MARKET RISK
• RISKS COMMON TO BOTH BOOKS ARE CREDIT, OPERATIONAL

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RISKS Contd..

• MAJOR RISKS ARE
• CREDIT RISK
• MARKET RISK
• INTEREST RISK
• LIQUIDITY RISK
• PRICE RISK
• OPERATIONAL RISK
• STRATEGIC RISK
• REPUTATION RISK

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RFISK MANAGEMENT

• IDENTIFICATION
• MEASUREMENT
• SENSITIVITY
• VOLATILITY
• DOWNSIDE POTENTIAL
• PRICING COVERING
• COST OF RESORUCES
• COSTOF OPERATIONS
• RISK PREMIUM
• CAPITAL CHARGE
• MONITORING AND CONTROL
• MITIGATION
• TRANSFERING

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BASEL 1 2

• THREE PILLARS
• TWO TYPES OF CAPITALS
• DIFFERENT METHODS OF MEASUREMENT OF RWA

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MARKET RISK

• HAS A COMPONENT OF CREDIT RISK IN ADDITION TO
  PRICE, LIQUIDITY AND INTEREST RATE RISKS
• LIQUIDITY RISK CAN ALSO BE DUE TO MARKETS
• RISK IN INVESTMENTS IS MEASURED THRO BPV,
  MODIFIED DURATION, VaR AND YIELD AND PRICE
  VOLATILITIES

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MONITORING CONTROL AND MITIGATION

• MONITORING
• POLICY GUIDELINES FOR VARIOUS ACTIVITIES
• CAPS FOR TRANSACTION SIZES, STOP LOSS LIMITS,
  GUIDLEINES ON PORTFOLIO SIZES BOTH TYPE AND
  INDUSTRY, EXPOUSRE NORMS
• MITIGATION THROUGH DERIVATIVES

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CREDIT RISK

• CREDIT SELECTION, PRUDENTIAL LIMITS
• CREDIT RATING
• CREDIT PRICING
• CREDIT MONITORING THROUGH RATING MIGRATION
• LOAN REVIEW MECHANISM
• CREDIT DERIVATIVES AND SECURITIES AND
  SECURITISATION

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OPERATIONAL RISK

• CAN BE CLASSIFIED BASED ON BOTH
• SOURCE, IMPACT AND EVENT
• RISK MITIGATION CAN BE THORUGH AUDIT, VARIOUS
  REPORTS

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OBJECTIVE QUESTIONS

• Q. RAROC STANDS FOR
• A. RISK ADJUSTED RETURN ON CAPITAL
• B. RISK ADJUSTED RETURN ON COST.
• C. RETURN ADJUSTED RISK ON CREDIT.
• D NONE OF ABOVE.
• Q.CREDIT DEFAULT SWAPS ARE
• A. ONE OF CREDIT DERIVATIVES.
• B. A KIND OF BANK GUARANTEE
• C. A KIND OF LINE OF CREDIT.
• D. STAND BY CREDIT.

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OBJECTIVES

• Q. THE BETA FACTOR FOR CALCULATING OPERATIONAL
  RISK UNDER STANDARDIZED APPROACH FOR RETAIL
  BANKING IS
• A. 12
• B.18
• C.15
• D. NONE OF ABOVE.
• Q. PROBABILITY OF OCCURRENCE 4 POTENTIAL
  FINANCIAL IMPACT 4 IMPACT OF INTERNAL CONTROL
  0
•   WHAT IS ESTIMATED LEVEL OF OPERATIONAL RISK?
• A. 3
• B. 2
• C. 0
• D. 4

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OBJECTIVE QUESTIONS

• INORDER TO DEVELOP ACTIVE CREDIT RISK MANAGEMENT,
  BANK MUST HAVE 1.GOOD CREDIT RATING MODEL AND 2.
  CONDUCT MIGRATION STUDIES
• both of the above are required
• Only 1 is required
• Only 2 is required
• both are insufficient

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• A transaction where financial securities are
  issued against cash flows generated from a pool
  of assets is called
• Credit default swap
• Securitisation
• Participation certificate
• Credit linked notes

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• A bank expects fall in price of a security if it
  sells it in the market. What is the name of such
  risk?
• Market risk
• Operational risk
• Asset liquidation risk
• Market liquidity risk

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• Credit rating agencies fix interest rates on
  bonds and debentures issued by companies
• a. true
• b. False
• c. Cannot say
• d. Only RBI can fix rate

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• An 8 year 8 semi annual bond has a BPV of Rs
  125.The yield on the bond has increased by 5
  basis points. What is the profit or loss suffered
  in price due to increase in yield?
• Rs 1000 profit
• Rs 1000 loss
• Rs 625 profit
• Rs 625 loss

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• A decline in CRR will cause the yield curve to
• Slope upward
• Slope downward
• Become flatter
• Remain unchanaged

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• Given the rating migration of 100 a rated
  accounts in bank during a year as under, please
  answer the number of accounts who suffered rating
  migration.
• A A A B B C Default
• 1 1 75 12 3 5 3
• a. 2 b. 23 c. 25 d. 21

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• ABC financial corporation has lent Rs 1500
  crores, at an average contractual rate of 14.
  Past experience indicates that the probability of
  repayment is 0.90 what would be the expected
  return rate of the corporation if the recovery
  rate of principal and interest is 0.95
• Expt. rate p r q (1 r) R -1
• Where p is probability of repayment q 1-p
• r is contractual rate and R is recovery rate

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THANK YOU AND WISHING YOU ALL SUCCESS IN
EXAMINATION